MAIN POSTULATES

Please read this page before reading the page entitled PRINCIPLES AND THEMES OF MACRO-ECONOMIC DESIGN

The purpose of these pages is to lay down the science behind Macro-Economic Design as seen and as created by the Macro-economic Design Team.

This page covees the main postulates made for PART 1 of the Volume 1.

It may become a part of the book.

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This part of the forthcoming book
is written for professional readers, and not for the general public.

It attempts to create a soundly
based science out of what has been found in the researches.

Briefly, the whole of the explorations made to date by the Macroeconomic
Design Team has revolved around how the economic architecture may be
distorting prices.

If prices are distorted by the way
we behave, the structures and the laws and regulations that we impose upon our finances
and the economy, then there cannot be a proper balance between supply and
demand.

The traditional response to this problem for the past century has been to
gather huge quantities of data at enormous expense and then to do the best we
can to manage the instabilities by selecting the interventions we think may be needed
to cope them.

In these studies that approach is
cancelled as being unnecessary. As long as those price distortions can be
eliminated there may not be a distortion, or an imbalance, to be fixed.

The one remaining intervention is
money creation – how it should be done, how fast, when, and how much data
should be known before the intervention is made.

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I
thought that writing the science was going to be easy – just listing everything
that has been a guiding principle that were used during our researches. But to
make it into a convincing science, it seemed that an exact definition was
needed as a useful proxy for aggregate demand in the economy. And there needs
to be a better definition of wealth than what we have now if we are to explain
how wealth can be protected from distortions in the economy. We need economic
structures / architecture that does not distort or transfer wealth from some
people to others dues to, for example, inflation.

It was
found that there is a significant link between the now preferred definition of
wealth preservation in savings accounts and the now preferred definition of
inflation of demand.

It
seems that everything revolves around incomes. If nuclear scientists are
looking for a unified theory of everything, this is like finding a unified
theory of economics and finance.

Let us
look first at the preservation of wealth.

Suppose
that a century ago a very wealthy man left a fund for his grandchildren
comprising half a typical person's lifetime income. Say 20 National Average
Earnings / Incomes - or 20 NAE for short.

The
fund increased in money value at the same rate as prices – which is the rate of
inflation as we normally refer to it.

Unfortunately
for the fund, National Average Earnings rose 3% p.a. faster than prices and the
value of the fund got left behind. It got left behind so far that by the time
the grandchildren inherited the money that it was valued at 1 NAE - a single
year's National Average Earnings / Income.

So when
we are talking of wealth preservation, as a result of these researches, we
prefer to talk about preserving NAE.

In
order to do that naturally, there should be a relationship between the rate of
growth of NAE and the rate of interest. The rate of interest may be higher or
lower than that rate, called the rate of Average Earnings Growth (AEG% p.a.), but
if the rate of AEG% p.a. increases by 1% then we should look for market forces
which will raise interest rates from what they were to a rate that is 1% p.a.
higher. Normally we just say 1% higher.

At the
same time, interest rates are a price - the price paid for borrowing money. If
the demand for borrowing is high then the interest rate will be marginally
higher than AEG% p.a. in order to balance the supply of money with the demand
for it. This additional / marginal rate will transfer some wealth from the
borrower to the lender.

And
that happens - the data looked at showed that on average, for housing finance,
the interest rate may be around 3% more than AEG% p.a. on average over the
longer term.

It was
hypothesised that this rate was a neutral rate. Above this rate borrowing and
spending would slow and below this rate borrowing and spending would increase.

That 3%
marginal rate may or may not be the rate that slows or increases borrowing in
the housing finance sector, but as far as the economy as a whole is concerned,
aggregate demand from borrowing and all other sources might be responsible for
this average rate of marginal interest above AEG in the housing sector. Each
sector has its own risk and demand related rate.

Above
that rate the whole economy would start to slow. Below that rate the whole
economy would begin to rise in its level of activity until there is full
employments or full capacity utilisation.

Based upon this hypothesis it was
decided to see how high the Federal Reserve Bank of America would raise
interest rates in the run up to the financial crisis in their stated quest to
curb inflation, as it was in the process of taking off.

The
estimated figure for AEG% p.a. at that time was 4% p.a. rising to 4.5% p.a. and
going higher.

This meant
that interest rates of 3.5% for housing finance would need to rise to 7.5% or
to be sure to curbing inflation as incomes were still rising, say 8% p.a.

Would
the Fed raise rates by 4% to 4.5% to achieve that? They tried. They got to
4.25% "with a little further to go" according to their then Governor,
Ben Bernanke.

The implication
for the housing sector with that debt repayment structure in force was a raise
in the cost of repayments of over 50%. The whole economic structure fell apart.
It was not necessary to have sub-prime loans. That just made matters worse.

So it
appears that the level of NAE and of AEG% p.a. are key parts of the economy.

It is therefore hypothesised that
all prices and that includes interest rates, should be able to respond nicely
to changes to NAE in the case of prices and, in the case of interest rates, to
changes in AEG% p.a.

If this
is correct, then it appears to be the case that incomes inflation is what
devalues money.

If all
prices, costs and interest rates an values adjust to changes in these indices,
then what a sum of money can be exchanged for, (goods and services) will remain
the same only if the amount of money increases at the same rate as NAE which is
at the rate of AEG% p.a. This then, is the rate of devaluation of money.

This gives rise to a further hypothesis:

The
rate of NAE inflation is the rate of inflation of demand which is the rate at
which prices, costs, and values increase, which is the rate at which money
falls in value.

Of
course that can go into reverse, and then we have deflation and a rising value
of money.

And of
course, there are many things that can get in the way of this relationship in
the short and medium term.

It is
important to note that AEG% p.a. is not the same as a rate of change of GDP
although GDP is supposed to be the aggregate of all incomes in an economy. But
GDP also varies with population and probably other factors too. Some economists
complain that it can be manipulated.

THE
BENEFITS

If we
can prevent the adjustment process from being distorted by the economic
architecture that we use, then we can have:

Savings
that can be protected from inflation or deflation, borrowing that is safe from
inflation or in deflation, defined pension benefits for defined contributions,
the cheapest possible way to borrow money because wealth gets protected if
interest rates move with AEG% p.a. We can have an optimum level of employment
and of economic growth...the list goes on and on.

INGRAM’S
PARADIGM SHIFT

This
is what Zoe Lindesay, a senior auditor on the capital side of Legal and
General, the largest manager of capital in the UK, calls Ingram’s Paradigm
Shift.

With
some exceptions, when statistics are issued, adjustments will in future be made
not to prices inflation but to incomes inflation – to AEG% p.a.

In
future, government debt may be index-linked to NAE in order to protect wealth.
This will be the cheapest way to borrow because the risk premium that has to be
paid on the debt will be as low as it can go. And there is a kind (slightly unstable)
match between a government’s net taxable income and the cost of borrowing in
that way. The key point is that it is the cheapest way to borrow with the
greatest market for debt that there could possibly be.

Governments
will have to pay a coupon (interest) of course and they may currently sell this
debt at a premium because interest rates are currently very much distorted.
This, and the various ways to structure that debt to address market needs is
discussed in the book.

Zoe
Lindesay proposed that this overall rate of return should be used as a
benchmark for the risk-free rate of return on any investment.

It
is well known that all investment values are influenced by rising incomes and
that pension funds invest heavily in assets like property and equities for this
reason.

With
the existence of Wealth Bonds which can be offered by governments, commerce,
and lenders for housing, any business, insurance company or financial
institution can use these bonds as a risk free or risk minimal asset for the
preservation of their asset base in line with any inflation of their risk
exposure, all else being equal – if the business is not expanding or
contracting, for example.

For
auditors like Zoe, this gives them a way to assess the risk exposure to the
capital assets of a company. Hitherto, the risk free rate and the value of
assets invested in government bonds has made a nonsense of such annual reports.
There is no way to come up with a definite figure.

For
lenders and borrowers, the concepts written above open doors to much less risky
lending and borrowing systems. All of these kinds of things are those which are
discussed in this book.

ONE
CAVEAT

There
is one important caveat which every economist picks up right away.

How
should we define NAE and AEG% p.a.?

The
fact is that the top 1% of all populations own a disproportionate amount of
wealth and in many nations they have a proportion of the world’s income which
seems to be steadily rising. Their share of national income is rising and so
their income is growing faster than the national average.

It
is even possible that this may continue until the time comes when no one has
any significant employment except in entertainment and other forms of human
interaction like the sax trade and Massage. Robots are coming. They may be able
to do everything else for us including the production or harnessing of green /
renewable energy. The means of production of those robots may be owned by what
remains of the top 1%. We can expect some awkward political issues coming our
way. And if they get resolved in good time, we may all look forward to that
day.

Maybe
robots will build or redesign and rebuild properties so fast and at no real
cost that we will not need loans or incomes.

In
the meantime, should we rather use the median level of income when it comes to
designing ways to borrow money?

These
are interesting questions that need to be resolved in order to complete the
science on that front.

Lenders,
for example, may decide to have their own index of borrowers’ average incomes
but they will still have to raise money at rates that compete with the rate of
return on assets generally. Those assets may be responding to NAE and AEG. That
will raise the marginal rate of interest compared to what borrowers’ incomes
are doing. 3% above AE% p.a. may be higher than 3% above the median rate of
earnings growth.

The
mathematics of lending says that this is not a big problem as it can easily be taken
into account. Much safer ways of lending can still be devised with just a small
modification.

DOES
IT MATTER

Does
it matter if we cannot agree upon the best definitions of wealth, or NAE, or whether
incomes really drive demand; or whether aggregate income actually drives
aggregate demand for a given population?

Consider
where we are now.

At
present we have no way to protect wealth. There is no such guaranteed
investment nor anything close to that.

Consider
the way that mortgage repayment levels are currently determined making no
allowance whatever for the possibility that incomes may start falling or that
interest rates may have to jump up so high that we have an economic disaster.

Consider
the struggles that central banks are now facing as they know that they must
raise interest rates but most attempts made recently in the developed economies
have been quickly reversed because the structure of bonds and hosuing finance
for example, must be getting in the way.

It
must be better to try something than to do nothing.

It
must be better to make some adjustments for the inflation of incomes and the
falling value of money than to do nothing.

When
an engineer sees that a vehicle has square wheels it is better to replace them
with oval wheels even if they are not quite round.